Sunday, December 27, 2015

When Will They Bottom? Crude Oil, SP500, then ExxonMobil

A full blown bear market in energy resources and energy stocks has been underway since mid-2014. History shows that the price of crude oil typically bottoms before the broad stock market. And oil related stocks bottom at the same time or later than the broad market. The monthly chart below shows how oil bottoms several months before the stock market does. This provides us with some insight on when we should start to expect a bear market to end in the US stock market.
Many traders follow and trade shares of Exxon Mobil. And while the are big money maker I do feel their share price is going to underperform oil for some time. Based on my research XOM has acquired many new oil operations, which many require $70+ per barrel to be profitable. This has cost XOM a considerable amount of capital and is now left holding and operating business that are losing money with the current price of oil sub $40 per barrel.


Base on my analysis, economic data and forecast I feel as though oil will remain low for another 3-9 months below $60 per barrel. It will do this for several reasons but what matter to us is that it forced the majority of oil producers to cap and close off well and go out of business. While this is taking place stocks and the economy will rebalance through a strong economic recession and a bear market in equities that will last most if not longer than 2016. Take a look at the US stock market average (SP500 index) in the chart below. While this chart is a very basic and simple looking forecast understand that the stock market internals and market breadth have completely collapsed just s we saw in 2000 and again in 2008 months before the index collapsed and started bear markets.

Oil, XOM, and Stock Trading Conclusion:
In short, I expect oil to find a bottom during the next 1-3 months. Oil services stocks on average are likely to trade sideways and build a basing pattern. These oil services stocks will not breakout and rally until the broad stock market has bottomed which I expect to happen late in 2016 or early 2017. Unfortunately, oil and oil stocks collapsed so fast without any retest or pause for us to get short and enjoy the ride down for profits. I feel trading oil and oil stocks will be choppy and tough in the near year. Last week subscribers and I played the energy (XLE) for a quick two-day pop of 2-4% return depending on entry and exit. These types of plays will continue, but the big trend trade in oil and energy are a long way away yet.
The easier money will be likely be shorting the stock market (buying inverse ETFs) to profit as stocks collapse which is what I provide subscribers to my ETF trade alert newsletter.
Chris Vermeulen – www.The Gold & Oil

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Thursday, December 24, 2015

Closed Another Winning Trade And New Forecast

Our trading partner Chris Vermeulen just sent over an email detailing his last trade of this holiday shortened week. Make sure to sign up for Chris' holiday special.....
Yesterday December 23rd we closed out a nice winning trade in XLE energy sector. If you have not yet closed the trade can should do so today and will locking an even larger gain of 4-5% return in only three days. The stock market closes early today at 1 pm ET. Today volume will be light and its not worth sitting around watching or trying to trade in my opinion. The best trade for today is to spend quality time with your family and friends.
Attached are couple charts that show where the market is currently trading with my short term analysis and why XLE position was closed yesterday. The market is primed for a sharp correction which may start Monday and if possible, we will take action, but volume will likely remain light for the rest of the year and first couple days of January, so the top may drag out a few more days. Let’s wait for a technical breakdown first before buying inverse ETFs.
overbought 1

I would like to thank all my followers and subscribers for their support and kind words throughout the year. It has been an extremely difficult market to trade with the broad market trading in a Stage 3 Distribution pattern. Hedge funds, mutual funds and those who hold individual stocks in their portfolio are all down sharply for reasons I have explained and warned about all year.

Early in 2015 I published a short book talking about how the US stock market was showing significant signs of a topping along with many timing cycles and events that were also unfolding and pointed to a new bear market that will likely last through 2016 and into 2017. Thus far, everything has unfolded as expected and once this Stage 3 Distribution pattern breaks down a new bear market will have confirmed and all kinds of huge trades will start to unfold. It will be a VERY DIFFERENT year than 2014 and 2015.
Chris Vermeulen – www.The Gold & Oil


Wednesday, December 23, 2015

By Far the Biggest Threat to Your Wealth in 2016

By Justin Spittler

Today, we begin with a warning. We’re going to tell you about a dangerous event that is very likely to happen within the next year. You’ve probably never thought about this threat. Until now, Casey Research has never discussed it in public. This threat isn’t a stock market collapse…it’s not a failure of the Social Security system…it’s not even a national debt or currency crisis. It’s much more dangerous and much more likely to happen than any of those things.

We’re talking about a major financial terrorist attack. A total wipeout of your financial data, assets, and records and those of many millions of other people. If you’re like most people, you think, “There’s no way that could happen here. Surely the financial system is completely safe.” But think about it….

If you have $100,000 in the bank, what do you really have?

These days, it’s not a claim to hard assets like gold or silver. And it’s certainly not real cash in a bank. Many local banks don’t even keep that much cash on hand! Just try asking your bank for $25,000 in cash. The teller will say, “We can’t give you that much money.” If you keep your life savings in a bank or brokerage account, what you have are electronic entries that hackers can easily and quickly delete. All the money you’ve earned...the hard work, the sweat, the sacrifice...the nest egg you’ve built to provide for your family, GONE. In an instant.

Cyberterrorists have already broken into the world’s most secure digital systems....

For example…..

➢ In May, hackers stole information on 300,000 private tax returns from the Internal Revenue Service (IRS). They used the information to claim tens of millions of dollars in fraudulent tax refunds.
➢ In April, hackers gained access to President Obama’s email. They gathered details on Obama’s personal schedule as well as private conversations with foreign officials.
➢ And earlier this year, we learned that a group of hackers infiltrated some of America’s largest and most sophisticated financial firms. The victims include JPMorgan Chase, E*Trade, and Scottrade. The hackers stole the personal data of more than 100 million customers. They even manipulated stock prices.

A large scale cyber attack could cripple the financial system….

E.B. Tucker, editor of The Casey Report, explains: In today’s high tech world, the lifeblood of our economy is a complex system of digital payments, digital book entries, and digital money. Billions of dollars are electronically transferred every day. We bank online, shop on our computers, and pay for lunch with credit and debit cards. Even the stock exchanges are now 100% electronic. The money in your savings, brokerage, and credit card accounts are just bits and bytes. A skilled hacker could steal it or make it vanish completely.

Enemy foreign governments are likely to attack the U.S.’s financial system.…

Here’s E.B....The U.S. has enemies all over the world: Russia, China, Iran, Syria, Iraq, and Saudi Arabia come to mind. There are millions of people out there who want to see the West burn. And it’s only a matter of time before they strike us at one of our most vulnerable points: Our digital financial system. As cybersecurity expert, Mary Galligan, recently told Bloomberg News, state sponsored cyberterrorism is “the FBI’s worst nightmare.”

The fallout from a cyberattack could be catastrophic….

E.B. explains…Just imagine, what if all of the accounts at a major bank like Wells Fargo were suddenly erased? What if businesses couldn’t process digital payments? What if your brokerage told you its records had been destroyed and all evidence of your stock portfolio had disappeared? What if a cyberattack shut down our electrical grid? I’ll tell you what would happen: An explosion of chaos. Society would break down. When people are wiped out financially, they’re often wiped out mentally and morally, too…they’ll do anything to survive, including resort to violence.

The government and central banks cannot protect you from cyberterrorists….

They don’t want people talking about this massive threat. They want to keep it quiet. You see, the U.S. dollar isn’t backed by gold like it was in the past. Our monetary system is built on confidence, and confidence alone. If lots of people questioned the safety of the system and pulled their money out, it could trigger a nationwide run on the banks, a stock market collapse, and a currency crisis. It could literally lead to rioting in the streets.

If you keep most of your money in digital form….

You must take steps to protect yourself and your family before an attack happens. The first step is to store a sizable amount of cash in a safe place you can easily access. We recommend at least three months’ worth of living expenses. Six months’ worth is even better.

You can store the cash in a safe, in a public storage container, or bury it in a waterproof container in your backyard. This might sound extreme, but think about it…if the financial system is compromised and your debit and credit cards become useless, you’ll need enough cash on hand to pay for groceries, gasoline, and other daily necessities.

Otherwise, you’re in a vulnerable position. Having no cash on hand means you could struggle to feed your family in an emergency. Because we believe most Americans are overlooking this huge threat, we put together a new special report titled “How to Protect Yourself from a Financial Terrorist Attack.” We talked with top cybersecurity experts and put hundreds of hours of research into this report. It explains seven specific steps you can take now to protect your money from financial terrorism. Click here to learn more.

Switching gears, the Dow Jones U.S. Trucking Index is headed for its worst year ever….

Yesterday, it closed down 17% on the year. It’s dropped 7.1% in December alone. The Dow Trucking Index tracks the performance of major U.S. trucking stocks. It’s only had three down years since 2001. Over that period, it’s averaged annual returns of 12%. The chart below shows trucking stocks have been in a clear downtrend all year.

E.B. Tucker says investors should watch this trend even if they don’t own trucking stocks. Trucks carry inventory to stores. They carry parts to the assembly plant. Then they carry assembled products to buyers. When sales are rising, it tends to show up in trucking companies before retailers. Trucking companies also feel the pinch first when sales are falling. This is why trucking stocks often give clues about where the market’s going long before other industries.

E.B. also says the collapse in trucking stocks is an early warning sign for the rest of the market. Transport stocks have given investors early warning signs for the past 100 years. Right now, the Dow Trucking Index is telling us business is not great. The trucks aren’t full. This is a dire sign. It’s saying we’re in for some negative surprises in 2016.

The U.S. stock market looks fragile….

From March 2009 through December 2014, the S&P 500 gained 204%. But the bull market has stalled this year. The S&P 500 is down 1% since January. If this trend continues, 2015 will the S&P’s first down year since 2008. On its own, this isn’t a huge concern. However, Dispatch readers know there are many other signs U.S. stocks have already topped out

For one, the current bull market in stocks is now 81 months old. It’s run 31 months longer than the average bull market since World War II. Of course, bull markets don’t die of old age. But they all die eventually. On top of that, U.S. stocks are expensive. The S&P 500 is now 57% more expensive than its historical average. Again, bull markets don’t end just because stocks are expensive. But expensive stocks can fall much harder during a big selloff.

We recommend investing with caution right now. You should own a significant amount of cash and physical gold...and you should sell any overpriced stocks that are vulnerable to an economic downturn.

Chart of the Day

Oil tanker rates are at their highest level in seven years. Today’s chart shows the daily shipping rates for very large crude carriers (VLCC), the second largest type of oil tanker. Each VLCC can carry 2 million barrels of oil. From 2011 through 2014, VLCC shipping rates averaged $20,000/day. This year, rates have soared 79%. Earlier this month, VLCC daily rates reached $112,775, their highest level since 2008.

Meanwhile, the price of oil has plunged 32% this year. Earlier this month, oil fell to its lowest level since 2009. Oil tanker rates can go up when oil prices go down…because ship operators charge based on how much oil they move. Their rates are not directly tied to the price of oil.

Dispatch readers know the world has a huge surplus of oil right now. All this oil needs to go somewhere, and oil tankers get paid to move it. As you can see in the chart, it’s a great time to be an oil tanker company.

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Sunday, December 20, 2015

Is the “Easy Money Era” Over?

By Justin Spittler

It finally happened. Yesterday, the Federal Reserve raised its key interest rate for the first time in nearly a decade. Dispatch readers know the Fed dropped interest rates to effectively zero during the 2008 financial crisis. It has held rates at effectively zero ever since…an unprecedented policy that has warped the financial markets. Rock bottom interest rates make it extremely cheap to borrow money. Over the last seven years, Americans have borrowed trillions of dollars to buy cars, stocks, houses, and commercial property. This has pushed many prices to all time highs. U.S. stock prices, for example, have tripled since 2009.

The Fed raised its key rate by 0.25%.....

U.S. stocks rallied on the news, surprising many investors. The S&P 500 and NASDAQ both gained 1.5% yesterday. The Fed plans to continue raising rates next year. It’s targeting a rate of 1.38% by the end of 2016. So, is this the beginning of the end of the “easy money era?” For historical perspective, here’s a chart showing the Fed’s key rate going back to 1995. As you can see, yesterday’s rate hike was tiny. The key rate is still far below its long term average of 5.0%.

Josh Brown, writer of the financial website The Reformed Broker, put the Fed’s rate hike in perspective.

The overnight borrowing rate…has now risen from “around zero” to “basically zero.”

In other words, interest rates are still extremely low, and borrowing is still extremely cheap. We’re not ready to call the end of easy money yet.

Cheap money has goosed the commercial property market..…

Commercial property prices have surged 93% since bottoming in 2009. Prices are now 16% higher than their 2007 peak, according to research firm Real Capital Analytics. Borrowed money has been fueling this hot market. According to the Fed, the value of commercial property loans held by banks is now $1.76 trillion, an all time high. The apartment market is especially frothy today. Apartment prices have more than doubled since November 2009. U.S. apartment prices are now 34% above their 2007 peak.

Sam Zell is cashing out of commercial property..…

Zell is a real estate mogul and self-made billionaire. He made a fortune buying property for pennies on the dollar during recessions in the 1970s and 1990s. It pays to watch what Zell is buying and selling. He was one of few real estate gurus to spot the last property bubble and get out before it popped. In February 2007, Zell sold $23 billion worth of office properties. Nine months later, U.S. commercial property prices peaked and went on to plunge 42%.

Recently, Zell has started selling again. In October, Zell’s company sold 23,000 apartment units, about one quarter of its portfolio. The deal was valued at $5.4 billion, making it one of the largest property deals since the financial crisis. The company plans to sell 4,700 more units in 2016. Yesterday, Zell told Bloomberg Business that “it is very hard not to be a seller” with the “pricing currently available in the commercial real estate market.”

Recent stats from the commercial property market have been ugly. In the third quarter, commercial property transactions fell 6.5% from a year ago. Transaction volume also fell 24% between the second quarter and third quarter., the largest online real estate marketplace, said economic growth is hurting the market.
Both commercial real estate transaction volume and pricing have showed signs of softening over the past few months. It’s likely that what we’re seeing is the result of reduced capital spending due to some weakness in the U.S. economy, coupled with a highly volatile economic climate in China and ongoing financial issues in Europe.

Zell is bearish on the U.S. economy..…

On Bloomberg yesterday, he predicted that the U.S. will have a recession by the end of 2016.
I think that there’s a high probability that we’re looking at a recession in the next twelve months.

A recession is when a country’s economy shrinks two quarters in a row. The U.S. economy hasn’t had a recession in six years. Instead, it’s been limping through its weakest recovery since World War II.
Zell continued to say that the U.S. economy faces many challenges.

World trade is slowing. Currencies continue to be manipulated. You’re looking at the beginnings of layoffs in multinational companies. We’re still looking all over the world for demand…
So, when you look at those factors it’s hard to see where strength is going to come from. I think weakness is going to be pervasive.

Like Zell, we see tough economic times ahead. To prepare, we suggest you hold a significant amount of cash and physical gold. We put together a short video presentation with other strategies for how to protect your money in an economic downturn. Click here to watch.

Chart of the Day

The U.S. economy is in an “industrial recession”. In recent editions of the Dispatch, we’ve told you that major American manufacturers are struggling to make money. For example, sales for global machinery maker Caterpillar (CAT) have declined 35 months in a row. In October, CAT’s global sales dropped by 16%...its worst sales decline since February 2010.

Today’s chart shows the yearly growth in U.S. industrial production. The bars on the chart below indicate recessions. Last month, U.S. industrial production declined -1.17% from the prior year. It marked the 19th time since 1920 that industrial output dropped from a positive reading to a reading of -1.1% or worse.
15 of the last 18 times this happened – or 83% of the time – the U.S. economy went into recession.

The article Is the “Easy Money Era” Over? was originally published at

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Tuesday, December 15, 2015

Origins and Strategy of the Islamic State

By John Mauldin

Today’s Outside the Box is from my good friend George Friedman of Geopolitical Futures. George, who founded the well known Stratfor, is one of the world’s top geopolitical forecasters. I’m very excited to welcome him as a Contributing Editor for Mauldin Economics.

Starting today and every Monday, we’ll publish a regular feature from George called This Week in Geopolitics. In this weekly letter written for Mauldin Economics, George will highlight the top international events that investors and those with an interest in geopolitics should monitor. I am amazed by how quickly George slices through the media’s superficial stories to reveal what is really important.

What you read in This Week in Geopolitics will be a small sample of the research George and his team publish. His Geopolitical Futures premium service is off to a great start and I highly recommend you try it. We have a special offer for Mauldin Economics readers. Click here for details.

As a reminder, I interviewed George in last week’s Thoughts from the Frontline. He had some fascinating thoughts on the connection between politics and economics, the European refugee crisis, China’s economic future and more. Click here to read it.

Today he examines the origins of ISIS and looks at why they see their behavior as rational. It is a disturbing viewpoint, and not one that will make us comfortable, but we do need to understand this. And it highlights the almost no-win position that the United States and the rest of the world (specifically the Middle East) is in.
In order to make sure this gets out Monday evening, I need to go ahead and hit the send button without further comment so…. with that, let’s go straight to George’s first weekly contribution.

[Editor’s note: if for some reason you do not want to receive George’s new letter each week, click here and we’ll take you off the distribution list.]

Your watching the world closer with George analyst,
Each week, John Mauldin highlights a thoughtful, provocativeessay from a fellow analyst or economic expert. Some will inspire you. Some will make you uncomfortable. All will challenge you to think outside the box.

Origins and Strategy of the Islamic State

By George Friedman for Mauldin Economics
Al-Qaida struck the United States on September 11, 2001 in order to pave the way for the caliphate, a multinational Islamic state governed by a caliph. From Osama Bin Laden’s point of view, the Christian world—as he thought of Euro-American civilization—had made a shambles of the Muslim world. Most Muslim lands had been occupied or controlled by Christians. After World War I the British and French, in particular, had reshaped these lands to suit them. They invented new countries that had never existed before like Jordan, Lebanon, and (in their minds) Israel and installed rulers on others, such as the Saudis in the Arabian Peninsula.

After World War II, the United States inherited a world the British had largely created. Where the British were the architects of this world, the Americans became its maintenance men. Since the Americans were caught up in a Cold War with the Soviets, the Soviets sought to create pro-Soviets as well. A new wave of rulers arose under Soviet tutelage. These were secularists, socialists, and militarists imposing military regimes.

Men like Gamal Abdul Nasser in Egypt, Saddam Hussein in Iraq, and Hafez al-Assad in Syria were all Soviet allies. They were despised by Islamists, as were the monarchies allied with the Americans. The secular Arab rulers were simply apostates. The monarchies, like Saudi Arabia, were corrupt hypocrites—formally Muslim but clinging to the Christians (now the Americans) for power and safety.

Al-Qaida did not yet exist, but there were those who dreamed of reclaiming the lands, expelling the apostates and hypocrites, and creating the caliphate. These men had learned the art of war under American tutelage in Pakistani camps after being recruited by the Saudis. They believed they had destroyed the Soviets and, as a result, destroyed the Soviet Union. True or not, this is what they believed.

When the Soviet Union fell, Iraq invaded Kuwait and the Saudis asked the American Christians to save them. Men who had fought in Afghanistan held the Saudis in contempt and were enraged by the Americans. To a great extent, the Americans were unaware of the response. The men they had trained for war in Afghanistan now saw the Americans as an obstacle to the caliphate.

This is the soil that gave rise to al-Qaida. Al-Qaida’s primary goal was to overthrow one of the secular or hypocritical regimes, create a Sharia-based caliphate, and use it as a base for creating a broader, transnational entity. Al-Qaida actually means “the base” in Arabic. It had excellent relations in Afghanistan, given the role it played there, but Afghanistan was too backward and geographically isolated to be the caliphate’s capital. It instead became the base where al-Qaida would begin the war.

In al-Qaida’s analysis, the weak and corrupt Islamic regimes could be overthrown, but the Muslim masses were inert, beaten into submission by Europeans and Americans, and convinced of American invincibility. They had no love for the Americans outside of some of the regimes, but saw their cause to be hopeless.

Al-Qaida needed to convince the masses that America was both vulnerable and hostile to Islam. It sought to strike the United States in a way that the Muslim world would take startled note, and that would compel America to go to war in the Muslim world. Al-Qaida’s experience in Afghanistan convinced it that the United States, caught in a war of attrition regardless of casualties, would eventually withdraw. The September 2001 attacks were meant to draw the Americans into combat but, even more, to convince the Muslim world that Muslims could strike at the heart of America, and then, when the Americans invaded, encourage Muslims to rise up in a long war America couldn’t win.

Part of the strategy worked, part of it didn’t. The attacks did galvanize the Muslim world. The United States showed itself to be Islam’s enemy by invading Afghanistan and later Iraq. The Muslim world saw that Muslims could fight Americans and not suffer defeat like the Jews had defeated the apostate Nasser’s army in 1967.

What did not happen was the essential step. While war raged in Afghanistan and Iraq, there was no uprising elsewhere in the Islamic world. When there were uprisings, as during the Arab Spring, they were put down (Egypt) or left in unending civil war (Syria and Libya). There was no foundation created for the caliphate, and over time American intelligence whittled down al-Qaida.

Others stepped into the vacuum as al-Qaida declined. Their opening occurred in Iraq and Syria. The Arab Spring in 2011 created an uprising against Bashar al-Assad, son of Hafez. Like much of the Arab Spring, the public faces of the protests were secular liberals, but they were unable to overthrow Assad. The resulting chaos and stalemate opened one door to al-Qaida’s heir.

At the same time, the U.S. decision to withdraw from Iraq, first made by George W. Bush and accelerated by Barack Obama, allowed a Shiite government to take power there. This forced their enemies, the Sunnis, back against the wall. Al-Qaida was Sunni and regarded Shiite Iran as an enemy. The rise of a Shiite government in Baghdad left the Iraqi Sunnis nowhere to go. It was out of this that the Islamic State arose. Syria and especially Iraq were its recruiting office and its battle ground.

Al-Qaida wanted an uprising in an existing country, but IS had a different strategy. Rather than overthrowing an existing government, it decided to create the state in a region that paid no attention to existing borders. Its goal, unlike al-Qaida’s, was to hold territory in which the caliph could rule and from which it could expand and guide the caliphate’s extension into noncontiguous Muslim lands.

The IS goal, therefore, was not to strike at the Americans as al-Qaida did. The 9/11 strikes had done their work. Their job was to create an area ruled under Sharia law with a governmental structure, financial system, welfare system, and the other things a state needs. In addition, and before this, IS had to create a military force that could take and seize land against the weak opposition it would face in Iraq and Syria.

The first step in the Islamic State’s strategy, therefore, was to put the caliphate before everything by taking control of substantial and contiguous territory. IS did this by carrying out a series of extremely competent military operations, seizing Mosul and Ramadi in Iraq as well as Palmyra in Syria. The result was a new state, no less artificial than those countries the British and French created after World War I, and governed from the capital in Raqqa.

In carrying out this operation, IS deliberately created a series of highly publicized atrocities. There were two reasons for this. The first was to intimidate the new Islamic State’s population. This region consisted of a wide variety of groups, many potentially hostile to the new state. The ruthless acts served to make clear to the population that IS was not merely claiming control of the region, but was in sufficient control that it was indifferent to what the outside world thought.

Having fought the Americans, IS knew that apart from special operations teams (the principle threat to IS in both Afghanistan and Iraq) which could not by themselves threaten the existence of IS, the United States took months to deploy forces. IS needed to show not only how ruthless it was, but that it would not be challenged as a result.

The second reason for creating this core was to lure the Americans into attacking it. The United States had grown wary of occupation warfare that required deploying a military force against scattered and persistent guerilla operations.

The Islamic State presented, and was, precisely the type of force the United States should be comfortable attacking. First, it occupied a clearly defined territory. Second, it contained a conventional military force. IS was not a guerilla organization or terrorist group, although it had elements capable of both kinds of operations.

The size of IS’ main military force (a force large enough to seize, occupy, and defend an area as large as some countries in the region) meant it could not be a guerrilla force. It appeared to be a mobile infantry force, moving by foot and truck, armed with infantry weapons as well as some small artillery and anti-tank weapons.

The exact size of IS forces remains a mystery, and that is a testament to its skills at camouflaging its activities from the ground to the electromagnetic sphere. Estimates of the size of its armed and trained force range from 20,000 to 200,000. Based on the extent of its frontiers and the casualties it seems to have taken, I estimate the force at about 100,000.

This, of course, leaves another mystery: where this force was trained—since training even 20,000 is a conspicuous activity. Units must train together to be effective. There are many mysteries about IS for which there is no consensus save educated guesses. We know the extent of its power. We know when this frontier is attacked, the attacker tends to encounter resistance. Beyond that, IS has protected its capabilities professionally.

Given all this, it would appear to be ripe for attack by American forces, which excel at this kind of warfare. That is precisely what IS wants. There has been much talk about IS believing that an apocalyptic battle must take place in order to establish the caliphate. This is a metaphysical concept on which I have no opinion.

However, from a political and military point of view, the caliphate must be founded on a decisive battle that forces capitulation from its main enemy. This would convince the US to respect the caliphate and the caliphate’s citizens to respect the power of the state. By this I don’t mean the guerrilla wars in which the conventional force simply withdraws; I mean a battle in which the enemy is defeated in detail.

The Americans prefer conventional attacks with tanks and infantry fighting vehicles. IS engaged and destroyed a Syrian armored brigade with anti-tank weapons. The United States uses air strikes and helicopters. IS may have man-portable surface-to-air missiles (and should have them from whatever source it secured the anti-tank missiles).

IS has a major advantage in one thing: the US is casualty averse. The US has a force operating at a distance for reasons that impact national security but don’t pose a direct threat to the homeland. Therefore, the American appetite for more serious military intervention is extremely limited. IS needs a decisive battle at any cost. Weapons aside, the outcome of this battle matters far more to IS than to the United States, and therefore IS’ threshold for pain is far higher.

The caliphate, having been established, must now be defended. It must be a territory and not a hideout, it must be coherent and not scattered tracts, and it must be defensible regardless of the cost. Having established its frontiers, the Islamic State intends to use minimal force to defend against minor attacks, as the Syrian Kurds carried out recently.

Most impressive about IS is its ability to retreat, regroup, and strike elsewhere. That is the measure of a military force. For example, the Americans proved themselves at the Battle of the Bulge when having been sent reeling, they regrouped, reinforced and struck back. It is in defeat that I judge a military force, and IS has handled defeat well. But we should also remember that IS will not waste force on marginal threats.

For IS, the main threat will come from the Americans and therefore it must preserve the ability to fight U.S. forces. Some point out that IS has been under pressure from all sides. This is because its leaders understand the maxim that he who defends everything defends nothing.

But the Americans have not come. Nor have other enemies like the Iranians or Israelis. Nor for that matter have the Turks. No one wishes to engage IS while it is on the defensive and at its best. There are many reasons, but the heart of the matter is that the battle, if lost, would be devastating for Americans, and if won by them opens the door to occupation warfare, as did the defeat of the Iraqi army in 2003.

IS must hold to save the caliphate now or, if it loses this battle, wait and fight another. And if the Americans don’t come and IS holds its territory, then IS can choose the time and place for its next strategic offensive.

Assuming that IS has 100,000 troops, the US must bring a force of 300,000 to bear under the old (and perhaps obsolete) rule of 3 to 1 on the offensive. It took six months to prepare for Desert Storm and longer for Iraqi Freedom with far fewer troops than 300,000. The terrain is desert, and supply lines will run from ports that have to be secured, along with roads that could be filled with IEDs. For the Americans, the logistics would be as tough as the battle.

Logically, the best course for the United States is not to engage. IS is beginning to realize this and seemingly prefers to force a battle. That is why we are beginning to see terrorist actions flaring in Western countries. The lesson al-Qaida taught IS is that the Americans have a threshold and that if you cross it, they will react dramatically.

Therefore, it appears to me that IS is searching for that threshold and probing to see responses. Attacks like the ones in Paris last month were not in response to French involvement in the region. These attacks are unconnected to that, but are designed to be as terrifying as possible—both in their suddenness and brutality—and compel a response.

It is odd to argue that someone wants to be attacked by the US. But IS needs the attack and also believes it can at least survive and likely defeat the Americans. It is clear that other countries in the region are steering clear of IS, and it is clear that President Obama is doing everything he can not to engage IS on the ground.

And it is clear that IS is doing what it can to drag the Americans deeper into the conflict. If the Americans don’t come, and no one else comes, the psychological demonstration might not take place - but the caliphate will exist. On the whole, IS has the strategic advantage in multiple ways. It behaves in its territory as if it intends to stay a long time.

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Monday, December 14, 2015

Evaluating Brazil

By Doug Casey

Editor’s Note: Casey Research originally published this article in January 2013. We’ve updated it with new, timely commentary. Doug’s analysis of Brazil is still vital today. They are timeless lessons on what happens to a country when a currency collapses.

Let’s explore Brazil, the “B” in the BRIC countries. It’s been getting a lot of applause as the new breadbasket of the world, and Brazilians are viewed as taking their place among the world’s new rich guys. I recently spent a week in São Paulo. I’d been to Brazil a half dozen times over the years, but never to São Paulo, a gigantic city that could easily be mistaken for L.A., except that it lacks the charm, is said to have vastly more crime, and speaks Portuguese, not Spanish. I was there to play in the Brazil Series of Poker, but also because I just wanted to see the place, since it vies with Mexico City to be the biggest agglomeration of people in the Western Hemisphere and is one of the biggest cities in the world. And it’s only a two hour flight from Buenos Aires.

It’s fairly easy to generalize about the other countries in South America. They’re all quite different from one another, but, relative to Brazil, each is small and homogeneous. For an American, getting to know Brazil is much harder than for a Brazilian to get to know the U.S. For one thing, it’s vastly more difficult to get around; you’ll basically have to fly everywhere. And the country hasn’t yet been homogenized with the franchise clones making cities and towns indistinguishable from one another. Brazil is a veritable subcontinent. Let me recall a few facts that almost everybody knows (and therefore are hardly worth mentioning), and also some that relatively few know (and that may, therefore, offer you some edge).

Brazil is somewhat larger than the continental U.S., has 5,000 miles of beachfront, and 190 million people. Nearly half of them are concentrated in the southeast, in just 10% of the country’s area. The countryside there roughly resembles Georgia in the U.S. One-third of Brazil’s GDP comes from in and around São Paulo, which is the functional center of the region. That city is where the action is, but it truly has no soul. It’s almost entirely of recent construction; what’s left of the quaint old downtown is now just a hangout for beggars, bums, and pickpockets. I consider the burg devoid of attraction, unlivable, and have no urgent desire to go back.

Only businesspeople go to São Paulo; tourists go to Rio, a much more appealing place. Surprisingly, Brazil only gets about 5 million tourists a year, and most of them are from neighboring Argentina. This is a very low number. France gets 80 million, the U.S. 60 million, Thailand 20 million, and Singapore 10 million. Cuba and Uruguay get about 2.5 million apiece. Even Syria reported 5 million in 2011 - a number I find hard to credit and which may include numbers of tourists who are heavily armed. Further proof you have to take all government statistics with a grain of salt; all the bureaucrats know is what someone casually puts on a form.

The good news is that a tourist number as low as Brazil’s can only go up, which is favorable, unlike most of what I’ll have to say about the place. And it will go up, because they’re hosting the FIFA World Cup soccer contest in 2014 and then the Summer Olympics in 2016. It’s completely unclear to me, however, where they’re going to put all the sports fans or how the visitors are going to get around and get on generally, even though the government plans on spending $20 billion on stadiums, airport upgrades, and road building to accommodate the crowds. Most of the money will inevitably be frittered away on monument construction, as opposed to things that make life easier or more pleasant.

Doug Casey: You might want to read my editorial about the ongoing FIFA so-called scandal.
I haven’t found Brazil to be convenient for anything. It’s extremely difficult to find a place to exchange even dollars - forget about other currencies. Except at major hotels, where you’ll pay a 15% fee. But there aren’t a whole lot of hotels, reflecting the low number of arrivers. And the average Brazilian speaks only Portuguese, although kids are learning either Spanish or English in schools. But how well did you speak a foreign language when you got out of high school? If I didn’t have some Spanish (which is much more comprehensible to a Portuguese speaker than vice versa), I would have been reduced to hand gestures.

That’s apart from the fact that illiteracy is officially figured at 10%, although my guess is that it’s much higher.

Demography, Cities & Race

São Paulo is different from Rio in every aspect. It’s flat, as opposed to mountainous. It’s non-centered, with numerous subcities, rather than being focused on the beach. It’s purely about business and getting ahead, as opposed to having a good time. Both cities are famous for their high rates of violent crime, emanating from the favelas, which are the shantytowns that ring all the major cities. They originated in the ’50s, when poor people started moving into the cities looking for opportunity. The cities were much more pleasant and more livable before the favelas arose - but they’re actually good things. They’re the first step to urbanization. And in the Third World, that’s essential for increasing literacy, improving incomes, and slowing the production of waifs and street kids.

When you think of the favelas, you might imagine the population is swelling. Just the opposite, actually. As people move into the cities, they redirect their attention from family to work, and women take advantage of modern birth control. Women find jobs, and there are few grandparents around to help raise the kids - who are now seen as an expense, as opposed to cheap labor for the farm.

So here’s a shocking statistic. As late as 1980, the average Brazilian woman had four children; the country was in the midst of a population explosion. As of 2011, however, the average was down to 1.8. The government estimates that in 15 years, it will drop to 1.5, which is far below the replacement rate of 2.2. This is happening almost everywhere in the world now, not just in Europe, North America, China, Japan, and other developed countries. The implications of this trend - which I believe will accelerate worldwide - are profound. But that’s for another article. Brazil is now essentially an urban country, with almost 85% of its 190 million inhabitants living in towns and cities.

The degree of urbanization relates not just to the birth rate, but to other phenomena, like racism and even slavery. Brazil has long had a reputation as a non-racist society. I think that’s true, even though it was the last major country in the world where the slavery of blacks as a group was abolished, in 1888. An event which is, in my view, irrefutable proof that the U.S. War Between the States was neither necessary nor essentially about slavery.

One reason there’s little antagonism between the races in Brazil is that the country never had a Lincoln, or a war, to polarize them. I think there’s going to be ever more racial harmony as more people live in cities and almost necessarily start seeing each other as individuals, as economic units, rather than as members of a racial group. There was no racial hostility that I could see. Slavery is still said to exist in the Muslim world, but only on an individual, as opposed to a legalized and institutional, basis. That’s because it’s completely uneconomic today; it’s hard to incentivize slaves to work productively in a high-tech economy.
Doug Casey: Actually, it does exist. I spent 10 days in Mauritania in June, where it was only officially abolished in 1987. But it still exists. Mostly because the slaves are well treated, and don’t have a better alternative.
And common laborers, doing grunt work, are less and less either necessary or desirable. Within a generation from now, intelligent robots will be doing most menial labor, making human muscular input almost redundant. But that’s just the culmination of a trend that’s been in motion since the start of the Industrial Revolution, when people started moving into cities on a grand scale. In those days, London had its own versions of the favela, as New York City later also did.

The fact is that the southeast of the country - the area from Rio on down - is socially very European, while the rural and undeveloped northeast is quite African. It’s mild de facto segregation. At the poker tournament I played in, there couldn’t have been more than 10 blacks among the 1,800 players. That’s partly a reflection of São Paulo’s demographics (even though, as a national event, people were from all over the country) and partly because the 1,800 real (US$900) entrance fee was prohibitive for those who aren’t solidly in the middle class. And in Brazil, that still leaves out almost all the blacks.
Doug Casey: You’ll notice the real has lost over half of its value in only three years. This is one reason why the average person here - who saves in reals - can’t get ahead.
But a rising tide raises all boats. The question is: What’s going to happen to the economy in Brazil? And how can you profit from it?

The Economy

Brazil has, from its very beginning, been plagued with dirigiste government. When it comes to papers to fill out, stamps and approvals to garner, layers of taxes to pay, and bureaucrats to soothe, it may be the worst place in Latin America. I think anyone who runs a business in the country is both a saint and a hero, although that’s becoming the case almost anywhere. The country has done as well as it has mainly because it’s so big, and Brazilians are used to dealing with Brazilians, mostly within Brazil.

The place has a lot of native wealth. You’d think it almost couldn’t help but be prosperous. But that would be untrue, as demonstrated by the Congo, which is a basket case despite being at least as rich in resources as Brazil; and with the counterexample of Japan, which is extremely wealthy despite having no resources at all except its people. Brazil is midway between them. For what it’s worth, the largest Japanese community in the world outside Japan lives in Brazil.

Except for the very recent past, the country’s history is all about dictators, military governments, and currency destruction - but its promoters overlook these things. You might think history would have taught Brazilians a lesson and shown them what not to do, so that they don’t repeat the same mistakes. But that’s not the way it seems to work. Instead, every disaster becomes ingrained as part of the culture. I admire the makers of the surreal movie Brazil for capturing much of the essence of the place.

There’s an old saying about Brazil: It’s the country of the future - and always will be. That may be true partly because it’s a closed economy and always has been. Brazil is essentially an island, cut off from the rest of the continent by a jungle. And the southeast, the developed part of the country, is cut off from the interior by the highlands. And it’s rather unlikely that a bridge is ever going to cross the Amazon anywhere near the coast; the river’s 200 miles wide at its mouth. The place could plausibly be at least two or three different countries. Brazil’s mainland links to the rest of the continent are Uruguay and Paraguay - both small, quiet, backward countries that offer little in the way of trade possibilities but do present a language difference.

China is now Brazil’s big export destination for iron ore, soybeans, beef, and chicken. But the China bubble is overdue to burst, and the country’s imports of iron ore are going to collapse. Brazil will feel it especially, partly because of shipping costs, since it’s literally on the other side of the planet from China, and partly because producing anything in Brazil has become expensive.

Iron ore neared $200 a tonne at the peak of the recent boom, up from about $20 at the 2001 bottom. It probably costs Vale, by far Brazil’s largest producer and largest company, about $40 to produce the stuff and perhaps $20 more to ship it. The ore currently trades at around $120 in China, but I don’t see why the price couldn’t collapse to less than production cost. Further, Australia not only produces the stuff for less than $30 a tonne, but is much closer to the Orient, so the shipping cost is half of Brazil’s. Vale is a heavily touted stock today. I wouldn’t touch it, for that and other reasons covered below.
Doug Casey: This, I’ve got to say, was an accurate call.
Brazil’s second-largest trade partner is the U.S. But what’s going to happen as the U.S. economy winds down? Third is Argentina, where exports are already collapsing because of the Kirchner regime. But it’s really incorrect to think of Brazil as a major force in trading. According to World Bank data, Brazil’s exports in 2011 amounted to only 12% of its GDP. The figures for Russia, India, and China were, respectively, 31%, 25%, and 31%. A few ag sectors qualify as exceptions, but overall the country is an isolated, self-contained island.

Brazil has made real progress over the last 13 years, since the bottom of the commodity cycle in 2001. Average prices of its commodities have gone up 2.5 times, and volumes have grown 50%. National income has boomed, more than trebled, in real terms. So, of course, the country has done well. But mostly for reasons extraneous to itself.


Over the last two decades, Latin America has become an increasingly important supplier of agricultural commodities to the rest of the world. In 1980, Latin America accounted for 30% of global soybean exports (oilseed, meal, and oil); in 2012, it accounted for over 60%. That’s mostly Brazil, in that while Argentine production has risen, punitive taxes under the Kirchners have kept it from rising by much. U.S. producers, meanwhile, have lost half their market share. Brazilian corn exports have gone from 11% of the world total in 1980 to 29% in 2012, while U.S. export numbers have collapsed due to the insane policy of turning corn into ethanol fuel.

Brazilian export numbers have boomed for coffee, sugar, beef, chicken, and orange juice as well. So a major argument by Brazil promoters is that it’s become the world’s food storehouse, and it’s going to grow from here. Unlike many of their arguments, this makes some sense, I think. But it’s not a good enough reason to invest there anytime soon.

Over the short term, global demand for agricultural commodities is likely to increase because, despite the downturn in world economic growth, world population is still going up. But even in Africa and the Muslim world, the population growth rate is slowing radically and will soon head down. The main driver for agriculture, in the long run, won’t be rising populations but rising standards of living.

Since the 1960s, world per-capita consumption of grains has increased at 0.5% per year compounded, on top of the growth in population. Planted area per capita has been declining, however, because of the expansion of the world’s cities, most of which were founded in prime agricultural areas. To compensate, new land has had to be cleared, and most of that has been in Brazil. Fortunately, advances in plant genetics, ag techniques, fertilizers, pesticides, and the like have increased production by something like slightly over 2% per year from 1970 to 1991, but at only half that rate since then. The result has been the commodity boom, mainly reflected in grains. But grains are poor people’s food. And they’re also highly political commodities, almost on a par with oil. I’m disinclined to invest in farmland for the grains.

I’m much more interested in specialty products, like grapes, olives, and other fruits. And cattle. Interestingly, cattle producers really haven’t participated in the recent ag boom, partly because they’ve been pushed onto less productive land, reflecting the weak profits for many, many years. Because of that, herds have been liquidated, and headcounts all around the world are at their lowest levels in three generations. That’s why I’m especially bullish on cattle. But that’s another story.

In the last five years, land prices in Argentina, Uruguay, Paraguay, and southern Brazil have risen 15% to 20% per annum. That’s mostly because, of course, grain prices have exploded. In the U.S., by comparison, farmland prices have only risen 10% per annum. Land in Latin America has done better partly because infrastructure had room to improve, and partly because the market is becoming ever more global because of generally lower tariffs and bigger, more efficient ships.

Will there be a worldwide shortage of arable land? I doubt it. The demand for grain is likely to flatten out. There’s an immense amount of underused farmland everywhere (especially in Africa). And I have no doubt technology will again increase productivity. So Brazil will grow in importance for food, but that’s not the bonanza a lot of promoters seem to think.


Around 400 companies are listed on Brazil’s main exchange, the Bovespa, for about US$1.2 trillion of market cap. By far the biggest are iron miner Vale and Petrobras, the national, state-controlled oil company.
Those two and 27 other Brazilian stocks are traded in the U.S. They’ve historically always traded at a discount to their foreign peers because of the country’s well-known problems - high taxes, intense bureaucracy, onerous import restrictions and duties, high crime rate, uneducated population, and subpar infrastructure.

As well as Brazil has done, it’s been a laggard by comparison to its peers in Latin America. In the last 10 years, corporate earnings in Latin America have grown on average by 18% annually. The countries that have recorded the highest earnings growth rates are Peru (28%), Colombia (23%), Chile (13%), and Mexico (12%). Brazil trails the list with 11% growth. During that time, Latin American stocks averaged a 10-to-1 P/E ratio. Most expensive (but deservedly so, as by far the most liberal economy in the region) was Chile, at 15, followed by Mexico, Colombia, and Peru with P/Es of 12. Brazil has historically traded cheaper, with an average P/E of 8. I attribute that to the country’s tax and regulatory structure.

According to the World Bank’s Doing Business 2011 report, Brazil is ranked 127th out of 183 countries for business friendliness. Mexico ranks 35th and Chile 43rd. Brazil scores particularly badly in categories related to starting a business, registering property, paying taxes, and closing a business. It’s Kafkaesque here, as in many other Third World countries, in that they make it nearly impossible to open a business (because they’re trying to protect those already in existence), and equally hard to close one (because they’re trying to protect the workers).

Say what one will about how screwed up Argentina is - and its economy is a real mess and getting worse - at least the country has a strong tradition of classical liberalism. There are a lot of Argentines who know who Mises, Hayek, and Rothbard are and who study their work; that offers some hope for a renaissance. That just doesn’t seem to be the case in Brazil.

Based on all of this, I can’t see buying Brazilian stocks. Actually, the place to look is Argentina, which currently has some of the world’s most tempting market statistics - a P/E ratio of 3 (whereas its average over the last 10 years has been 12); a price-to-book-value ratio of 0.9 (versus an average of 2.0 over the last 10 years); and a dividend yield of 13% (versus an average of 4.2% over the last 10 years). Argentina is a bargain. But, like most bargains, nobody wants to touch it.
Nick Giambruno: Casey Research originally published this article in January 2013, and the Argentine market went up by more than 200% over the next 33 months.


I’ve mentioned how brutal Brazilian taxes are. They’re a major reason everything in the country is so expensive - especially imported items. I decided to find out just how Byzantine the regime might be. Suppose you decide to import something to take advantage of the country’s vaunted growth. It had better be a highly desirable, extremely high margin item, because there are six levels of tax on imports, and they compound, each tax being levied upon the previous taxes. Nothing leaves the harbor before your check clears.

I’ll list them in the order they’re applied. On top of one another. They’re generally referred to by their Portuguese acronyms, in parentheses, to avoid confusion.
  • Merchant Marine Renewal Tax (AFRMM) - 25% of the shipping and port handling costs. Used to subsidize the merchant marine and shipbuilding industries.
  • Import Tax (II) - From zero to 35%, depending on the product. The level depends largely on which domestic industry they’re trying to protect.
  • Industrialized Products Tax (IPI) - From zero to 20%. Another protectionist tax.
  • Merchandise and Services Circulation Tax (ICMS) - This is essentially a VAT, levied by the states. It averages 18%, but ranges from zero for some “essential” items, to 25% for “luxury” goods.
  • Contribution to the Social Integration Program and Civil Service Asset Formation Program (PIS/PASEP) - 1.65%.
  • Contribution to Social Security Financing (COFINS) - 7.6%.

More Taxes

But I’ve only mentioned the import duties. The Corporate Income Tax (CIT) runs from 25% to 34%. Plus there are lots of rules regarding deals with related companies, companies in low-tax jurisdictions, and outbound interest payments. This is because, living in both a Latin culture and a high-tax jurisdiction, the Brazilians have grown expert at denying revenue to their voracious government. The government, in turn, adds more layers of rules.

Of course there’s also a personal income tax ranging to 35%. Then, on top of it, is Social Security (INSS) tax of 20%, accident insurance (SAT) of 1% to 3%, Employee Indemnity Guarantee Fund (FGTS) and Education Fund (SE) of 2.5%, plus assorted other taxes adding up to another 3.3% of income. There’s even a 10% tax on the acquisition of foreign technologies. This isn’t a treatise on Brazilian tax law, so I haven’t researched the limits, exclusions, exemptions, and deductions. But if you’re going to do anything here, you’d better have a good accountant.

Total import taxes can easily add up to 100% or more. It’s actually quite insane. Countries like Cuba and Iran complain about being placed under trade embargo and suffering from the dearth of imports. But Brazil - and, for that matter, almost every country in Latin America and Africa - effectively puts itself under embargo with its own tariffs. Brazil, Uruguay, and Argentina are by far the worst self-tormentors.

Restricting purchases to things made within the arbitrary borders of one country (almost always to subsidize some inefficient local industry) makes about as much sense as limiting purchases to things made within a state, a county, or a city - or within a city block, for that matter. What’s happened in Brazil, as with all these places, is that it’s full of uneconomic industries, which turn out relatively high-cost/low-quality products. And often with a surfeit of workers - since keeping lots of workers on the payroll is considered smart public policy. That makes it very hard to make a sensible investment in these places.

It’s all happened before. Eventually reality wins out, and out of either intelligence or simple necessity, the duties come down, the protected industries collapse, and lots of workers become unemployed. The bigger and richer a country is, however, the more mistakes it can make before its eventual comeuppance. And Brazil is a rich country. In other words, Brazil has created some artificial and temporary prosperity in exchange for a very real depression sometime in the future. Neither an individual nor a country can get rich by producing inefficiently and wasting resources.

So Brazil should be doing vastly better than it is now and be on a much sounder foundation. But first it’s going to have to liquidate a lot of malinvestment and allow the severe distortions that have built up over the decades to unwind themselves. It won’t be fun, and it’s going to happen regardless of what’s going on in the rest of the world. This is a major factor that Brazil’s lately arrived cheerleaders either don’t see or don’t understand. It’s why Brazil - as with all controlled, politicized markets - has to be treated as a speculation, not as an investment.

History Equals Culture

Let’s take a look at where Brazil has been to get a better grip on where it’s likely to go.
Brazil split from Portugal in 1822 (about the time the rest of Latin America was breaking political ties with Spain), but remained a monarchy. After independence, the head of state was styled “Emperor” until 1889. (Would the U.S. be the country it is today - yes, the description is loaded with irony - if it had been a monarchy that late in its life?) The next 40 years saw political instability, with alternating military and oligarchical governments, essentially all financed with coffee exports. In 1930, a military coup installed the Vargas dictatorship, typical of governments the world over in the ’30s in its promotion of industrialization by state-owned companies. It survived coups by both pro-Communist and pro-Nazi elements while resembling both.

Another general was elected president in 1946, followed by one headstrong statist after another promising the era’s version of hope and change, by making “50 years’ progress in 5 years.” Part of that promise included moving the capital from Rio to Brasilia, a city built from whole cloth in the middle of the jungle, in the middle of nowhere, starting in 1956. Three million people now live there, so it has been construed a success by some. I think it’s better described as an ongoing disaster and a monument to the gigantic size, complexity, and cost of the Brazilian government.

Brazil was again a military dictatorship from 1964 to 1985, with all the things that have come to be expected from a banana republic ruled by generals - repression, torture, corruption, and runaway inflation. This brings us to the current era, with the ascension of Fernando Collor de Mello in 1985, then the first elected leader in 29 years. He started a trend toward liberalization - beginning the privatization of companies like Vale, Embraer, and Telebras - and toward political moderation that’s been in motion since.

Predictably, Collor de Mello was tried on corruption charges. I say it’s predictable both because enemies of liberalization wanted to punish him and because it was inevitable that, with lots of new capital being liberated, some of it would stick to the president and his cronies. That’s what politics is all about everywhere.

A big change came in 1994 with the invention of the real, the present currency, which was initially priced at US$1.25. Brazilians were overwhelmed at the thought of their currency being worth more than a dollar, even if only for a while. Surprisingly, the currency has been managed fairly prudently, losing just 60% against the dollar over 20 years. Part of the real’s comparative durability was that Brazilians were reacting against the immense inconvenience of one currency destruction after another; part was the simultaneous partial liberalization of the economy on a number of fronts, especially imports.

But when Lula da Silva (who’d run for president twice before) was elected in 2002, the real collapsed to US$0.25, because he and his leftist party had long promised to roll back what reforms had been made and return to a more closed economy. Surprisingly, da Silva proved quite moderate. And he had the singular good luck to be elected at the beginning of the great commodity boom, which brought lots of capital into Brazil, facilitated nearly full employment, and increased the value of the real to its current two to the U.S. dollar.

It was a given that his protégé, Dilma Rousseff, would easily be elected in 2011. Rousseff used to be a communist radical, but like da Silva, she’s acted in a fairly responsible and reasonable way so far. She’s even talked about freeing the economy further and reducing some taxes. These things are possible. But so far she’s been presiding over good times. When things get tough, it’s likely she’ll return to her intellectual and psychological roots, and the government will act the way it usually has.

So I wouldn’t plan my life around meaningful liberalization in Brazil. Or good times in any of its markets. One reason is that the commodity boom has already run a long way, and further gains are likely to be marginal in real terms. But a bigger reason is simply the country’s history and culture - dictators, generals, chronic inflation, and consistently destructive economic policies. When the world economy turns down in the near future, it’s not going to help Brazil. They’ll likely revert to form. Or simply act like almost every other government in the world today and “do something.” Brazil is a prime example of the wisdom of the old saw “Never invest in a country that has the color green in its flag.”

Culture and Currency

Four recently published books promote Brazil as the place to be, mainly because it’s a BRIC that has established a great “track record” since 2001. This is typical of what happens at the top of a bubble. When stocks are at a peak, people want a book about how the Dow is going to 40,000; this is true across all times, places, and markets. People are now writing books on Brazil.

But it’s almost always a mistake to buy popular investments and speculations. In order to make serious money, you have to buy while something is cheap and unwanted, even unknown - better yet, despised. Not after it’s expensive and everyone’s hungry for it. People tend to confuse investments with people. When it comes to people, track records are critical. With people, past performance isn’t just the best, it’s essentially the only predictor of future performance.

Someone who has exemplified the Boy Scout virtues in the past is likely to continue on that course; someone with a panoply of vices and bad habits is likely to carry them to a bad end. The same is true of companies, at least until management changes. But even when it does, corporate culture lingers for a considerable period. This is even more the case with countries. Change in a country’s culture takes generations, if it happens at all.

Everyone talks (quite correctly) about how totally irresponsible Argentina has been with its currency, but Brazil’s follies have been forgotten in the celebrating of its success over the last 15 years. You may find a comparison of interest.

Argentina has had only five currencies in its modern history - the peso moneda nacional (PMN), the peso ley, the peso argentino, the austral, and the current peso convertible. The PMN was used from before WWI until 1970. In its early days, it was tied to gold, and the PMN traded at about 2.25 pesos to the dollar. It started slipping after the Great Depression began in 1929 and then went from 4.2 (to the dollar) in 1947 to 15 in 1950. At that point Peronism, a peculiar blend of corporatism, populism, socialism, fascism, Keynesianism, militarism, nationalism, and other variants of statism that seemed like good ideas at various times, took over. And the ideas have never let go of the popular Argentine psyche.

In 1970, the PMN was replaced by the peso ley, for a 100-1 rollback.
In 1983, the peso ley was replaced by the peso argentino, for a 10,000-1 rollback.
In 1985, the peso argentino was replaced by the austral, for a 1,000-1 rollback.
In 1992, the austral was replaced by the peso convertible, for a 10,000-1 rollback.

This happened with the election of Carlos Menem, who greatly liberalized the economy (while facilitating grand larceny among his cronies). Menem maintained this peso’s relative value with a currency board, wherein the central bank was supposed to take in and hold one U.S. dollar for every peso it issued. They kept to that for a while, then started fraudulently issuing extra pesos, which led to the famous crisis of 2001, with a 75% devaluation.

If you’d held Argentine currency through its various replacements over the last 100 years, you’d have retained only 1/70 trillionth of its original value. At the moment, the peso has an “official” value of 4.7 to the dollar, but trades on the semi-illegal free market for 7 to 1. It’s on its way to zero again. The history of currency in Brazil is even worse, despite the Banco do Brasil mission statement’s talk of “ensur[ing] the stability of the currency’s purchasing power and a solid and efficient financial system.” But all central banks say that.

Brazil long maintained its original real from the 18th century and then replaced it with the cruzeiro in 1942, for a 100-1 rollback.
In 1965, the cruzeiro novo replaced the cruzeiro, for a 1,000-1 rollback.
In 1986, the cruzeiro novo was replaced with the cruzado, for a 1,000-1 rollback.
In 1993, the cruzado was replaced with the cruzeiro real, for a 1,000-1 rollback.
In 1994, the cruzeiro real was replaced with the real, for a 2,750-1 rollback.

Since then, the real has lost about two thirds of its value relative to the dollar. I see no reason why it shouldn’t meet the fate of its predecessors. I calculate destruction against the dollar so far at about a quadrillion to one. But numbers of this order of magnitude are academic. I fully expect that, when the pressure for revenue and economic stimulus next arises, the Brazilians will once again destroy their currency.

The Bottom Line

My view is that in today’s world, it’s extremely hard and risky to invest. You must remember the correct definition of investing: to allocate capital to produce new wealth. Essentially that amounts to buying equipment, hiring people, renting real estate, and seeing that a business is run sensibly over the long term.

Investing is all about funding successful businesses. In order for that to be possible, you need some predictability and a certain amount of stability. Unfortunately, those are ingredients that go into short supply whenever government gets involved in the economy. And today, from what are already the highest levels in modern history, governments all over the world are becoming much more virulent. And since most of them are now manifestly bankrupt but are burdened by huge promises for welfare and transfer payments to the masses who voted them in, you can expect things to get even worse.

When there are no opportunities for investing, you can only speculate, which means, look for politically caused bubbles, collapses, and distortions. Brazil should only be viewed as a speculation. As chronically and pathetically mismanaged as Brazil has always been and continues to be, it’s astonishing how well it’s done. And there’s no reason that it shouldn’t continue progressing, despite the weight of government and its seeming inability to learn from its mistakes. People will keep producing, and technology evolving.

Am I negative on Brazil? No. I highly recommend you visit, especially before FIFA in 2014. I really like the country (notwithstanding São Paulo). But it’s not a sure ticket to wealth. In fact, over the next decade, I’d recommend you stay away from Brazilian markets. But armed with this information, hopefully we’ll recognize the Bovespa’s next bottom.
Doug Casey: Hmm...maybe the bottom is close now. Or certainly closer.

Editor’s Note: Doug Casey has been warning of a currency collapse. He believes a collapse of major currencies could wipe out trillions of dollars in wealth, including pensions. Here’s Doug:
It’s going to be much more severe, different, and longer lasting than what we saw in 2008 and 2009…The U.S. created trillions of dollars to fight the financial crisis of 2008 and 2009. Most of those dollars are still sitting in the banking system and aren’t in the economy. Some have found their way into the stock markets and the bond markets, creating a stock bubble and a bond super-bubble. The higher stocks and bonds go, the harder they’re going to fall.

Unlike most people, Doug Casey has actually lived through a currency crisis. He was in Argentina when its currency collapsed in 2001 during the largest sovereign debt default ever. By making smart investments, he even managed to make a large gain on his money in the aftermath of the crisis.

We recently recorded a video presentation with Doug on this topic. In the video, Doug shares his advice on how to position your money and investments for the collapse of a major currency like the U.S. dollar. Click here to watch the video.

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